The research credit (often called the “research and development” or “R&D” credit) incentivizes businesses to step up their investments in research. Although calculating the break isn’t exactly easy, the end result can be well worth the effort.
Generalities and specifics
To be eligible for the research credit, an innovation-seeking business activity generally must:
- Relate to development or improvement of a “business component,” such as a product, process, technique or software program,
- Strive to eliminate uncertainty over how (and whether) the business component can be developed or improved,
- Involve a “process of experimentation,” using techniques such as modeling, simulation or systematic trial and error, and
- Rely on “hard science,” such as engineering, computer science, physics, chemistry or biology.
You may work with engineers and architects who engage in theoretical concepts and inventive designs all the time. But, as the “boots on the ground,” you may not believe you’re in a position to pioneer new ideas.
Yet contractors can absolutely do so. For instance, safety is obviously a major concern in the industry. By developing safer and more efficient construction techniques and methods, you could qualify for the credit.
Another example is the still-relevant sustainable building sector. Eligibility can be triggered by helping to design buildings, features or systems that improve energy efficiency or facilitate LEED certification. And if you happen to work in the HVAC, electrical, plumbing or lighting areas of construction, contributions your company makes to new and improved systems could allow you to claim the credit.
Last, if your construction business is on the cutting edge of technology and involves itself in software design, it’s highly advisable to look into your eligibility for the research credit. Innovations in, for instance, estimating software or building information modeling systems could do the trick.
A good place to start investigating your eligibility for the credit is your contracts. In fact, their very structure could determine whether you should continue pursuing this tax break. Why? Because, to claim the credit, you must bear at least some of the financial risk associated with the research and enjoy substantial rights to the results. Otherwise, the effort will be considered “funded research,” which is ineligible for the credit.
Typically, research performed under a fixed-price contract is more likely to be eligible for the credit because the contractor bears the financial risk (provided he or she also retains rights to the results). Conversely, research performed under a cost-plus or time and materials contract will likely be considered funded (and, therefore, ineligible) because the financial risk remains with the customer.
Let’s say you do qualify for the research credit. What’s in it for you? You could receive a dollar-for-dollar, nonrefundable credit of up to 6.5% of qualified research expenditures (QREs), which include:
- Wages and supplies related to qualified research activities,
- Calculation costs, and
- 65% of research fees paid to certain contractors.
“Nonrefundable” means the credit can’t exceed your tax liability for the year. You can’t use it to generate a loss and claim a refund. But unused credits may be carried back one year or forward up to 20 years to offset your tax liability in those years.
Remember, simply conducting research isn’t enough to qualify for the credit. Rather, you’ve got to show that your company has increased its established research activities. This may call for establishing some foundational innovation efforts and then ramping them up over time.
Calculating the credit is complex, and there are several methods for doing so. But, essentially, it’s equal to a percentage of the amount by which your current-year QREs exceed a base amount.
The research credit was made permanent under the Protecting Americans from Tax Hikes (PATH) Act of 2015. For more on this, read our post titled PATH Act bonuses for smaller construction companies. As of this writing, there’s been no indication that it will be affected by rumored tax reform efforts in Washington.
Given the credit’s aforementioned complexity, work with your CPA to determine whether you might claim it and, if so, how to handle the calculations involved. The research credit may not be the easiest way to save tax dollars, but it’s worth giving some serious thought.
We welcome the opportunity to put our construction industry expertise to work for you. To learn more about how our firm can help advance your success, please contact Dave Wolfenden at (302) 254-8240.